The Effect of Capital Structure on Financial Performance: Ethiopia’s Metal and Engineering Industry

Abstract:

In Ethiopia, recently there are few capital structure studies that focused on determining firm
specific and macro economic factors responsible to affect capital structure decision; in these
studies researchers include either profitability or performance of companies to understand
whether it had an effect on capital structure selection but they ignored the reverse effect of
capital structure on financial performance of companies. To understand this reverse effect this
thesis analyzes the effects of capital structure and debt maturity choice on financial performance
using audited financial statements collected from each 10 sampled companies of Ethiopia’s
Metal and Engineering Industry for the time span of six years (2007 to 2012). The multivariate
OLS regression result of the study indicates capital structure has a significant and positive effect
on financial performance (measured by return on equity) of the Metal and Engineering Industry
companies as it is measured by debt ratio; furthermore, short term debt ratio has significant
whereas long term debt ratio has insignificant but both positive effect as the study examined if
different level maturity of debt has a different effect on financial performance. Thus, the study
concluded that data from Ethiopia’s metal and engineering industry companies support Trade-
off theories and despite to their significances no different effect in direction on financial
performance was found caused by levels of debt maturity. On the other hand, asset tangibility as
a controllable variable was found to have a significant and negative whereas company size and
asset turnover were not. Finally, the study recommended that companies in Metal and
Engineering industry should employ more debt in to their capital structure; however, the
industry companies should give a through consideration to determine the optimal point to which
they exhaustively take the benefits of debt; otherwise they will be exposed to bankruptcy risk due
to excessive utilization of debt